ETF Edge - Active ETFs rocket past $1T, 10% of AUM 3/31/25

Episode Date: March 31, 2025

Amid the market volatility, demand for actively-managed ETF strategies has been unrelenting. This industry is more than happy to serve. But, here’s what investors need to know about them.  Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

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Active funds passed $1 trillion in assets under management. It's now almost 10% of the AUM of ETFs. Is that good or bad for market? market volatility. Here's my conversation with Todd Sone, head of ETFs for Stategis, and Nate Geraci from the ETF store. Nate, 30% of the inflows into ETFs this year have been into active funds. That's another record. Now, when I think of active management, I think of old-fashioned stock picking, you know, like Kathy Woods-Arck funds. Is that what's going on here, or is there something else? Well, if you look at where the bulk of the flows are going, it's actually

going to much more systematic strategies versus the traditional stock picking active managers that we like to think of. So if you look at the types of issuers such as Dimensional, J.P. Morgan, Avantus, the flows are really going into the lower cost, more rules-based active strategies. But I have to say it's interesting for an industry where the roots are passively managed products, that's what the industry was built on. It's interesting to see active ETFs getting all of the attention right now. Yeah, I want to talk about that, Todd.

But is there any other correlation this rise in volatility with the rise in active? I would look at it in two different ways. For equity, you have unprecedented concentration, right? Ten largest stocks were 40% of the index. Now they're declining. So there is a want for active, whether it's a differentiated exposure like Nate just talked about with DFA and Avantus, or the uses of options to generate income in order to protect to an extent of the downside. That's for the equity sleeve.

And then on the fixed income side, we've had rate normalization. QE's over and long duration doesn't work anymore. So you want an expert at the wheel, I think, in terms of fixed income. That's where active matters. So the bottom line is the lion's share of these. I'm trying to figure out how to slice and dice this to explain it to the viewers. The lion's share of these active ETF assets are in the low-cost issuers that have factor tilts, for example, like dimensional and avantis.

These people tend to have an influence in terms of factors where their value or growth, small cap, big cap, something like that. They're less career risky, I'd say, for financial advisors out there, right? You're not deviating too much from the benchmark, but just watering it down concentration. I'm just trying to point out that this is different than old school active stock picking here, where you're sort of indexing plus here with that. Yeah, we went through the old school stock picking scenario back in 2020 with innovation and disruption. And that was great for a time and some folks got burned by it.

And then there are those that are doing income generation like JEPI, for example, JEPI, for example, that are out there. That's considered active. I guess this is what the hard part I have with this. They consider this active. Even for something like JPMorgan premium income, they're still picking a portfolio of stocks based on low volume quality. And then they're just managing the option sleeve of that too. So you need a professional at the wheel for that one as well. Right.

And then you have others that are buying downside protection, these buffer products that we've been talking about. Yeah, I think buffer has to do with demographics, right? You have investors, whether baby boomers, whatnot, who've been invested for years, and they don't want to have that whole nest egg blow up within a week or two, especially in a very wild geopolitical environment. And so that's where I think the buffer comes in. They can still get equity exposure, but at least have that peace of mind at night, so they're not going to end up in an 08 or 2,000 type scenario again.

Yeah. So I guess, Nate, the days of investors paying up for closet indexing are essentially over at this point, right? I mean, these active products, while they're not old school stock picking products, there are aspects of active management to them, and they are fulfilling a clear need for the market, right? So, I mean, people who are getting older want income generation, right? So there's a product that makes some sense to me. People who are worried about the market decline but still want to stay. stay in the market, they might want downside protection so they'll buy buffer products. These are all fall into the rubric of active investing, even if it doesn't involve old school stock payment, right? Yeah, I think it's a great point in that when you look at the growth and the number of

actively managed ETFs out there and where the assets are going, these aren't what you necessarily think of as traditional active. And it is products like options-based income ETFs, buffer ETS, that they're technically active on the tin, but if you look under the hood, again, it's not what you would necessarily think of that traditional active management. I think the key point here is that an active manager either needs to be cheap, they need to have low fees, or they need to have high active share. The days of investors paying up for closet indexing, those are over, Bob. Investors just aren't going to pay for active management that looks like an index fund because they can already

get that exposure very inexpensively. And so a manager either needs to be low cost or the strategy needs to do something much different than the benchmark. It needs to be high active share. Yeah. So even when you have companies like Dimensional and Avanthus, indexing plus I call it, they're very low cost. Yeah, 20 basis points, maybe give or take a few five or so. So that's not that expensive to compete with. Right.

The advisors say can stomach that easily. Yeah. What I find interesting is just how active has expanded. I mean, there's a sort of natural tendency in this industry to expand into new products because that's how you could charge higher fees, right? I mean, any kind of active charges more than a passive fee. That's the high fees come from the really exotic active, the levered space, right? Ones that are putting on 2x one and a half times on single stocks or on different components

of the market like tech, internet, semiconductor, something like that. So there you can charge 90 basis points. Yeah, and you kind of have to in order to get the economic stride, but it's a different But that's a very unique corner of active itself. But there are 100 or so single stock ETFs now. That's also been part of the whole rise of active too. Yeah. We've also been seeing big inflows into active fixed income, Nate,

largely because investors are flocking to these ultra-short funds that we see. And we'll put a few of them up. But is this because the yields are so attractive? I mean, some of these are 5% right now, right? I think certainly the yields help. but to what Todd was alluding to, there's a lot of uncertainty over the rate environment moving forward. And I think especially for financial advisors, they seem in general to feel much more comfortable about their ability to navigate the equity markets and not quite as comfortable navigating the fixed income markets.

And you add to that that if you look at the data, the data would show that active fixed income managers do have a better performance track record than their equity manager counterparts. And so I just think some advisors are much more comfortable using active fixed income ETFs. They just see more value here. Do you think that's true? I mean, this is a claim that the active bond guys have been making. Oh, we know that active stock picking doesn't outperform in the long run. You know, you know, the studies is pretty clear. They don't. But they have been making claims for the last couple years that active bond managers can do a little bit better.

The ag is flawed. There's no high yield in it. There's no, I want to say asset back securities and mortgage-backed securities. So if you're a smart fixed-income manager and you know your markets, you know your economics, you can get the exposures for that. I think that's why you're seeing this. So you don't, well, that's a good point. The ag, he's referring to the primary...

Yeah, the S&P of bonds, $500 of bonds, right? So the old Lehman Brothers Index now. That's an aggregate of all sorts of different bonds. Doesn't have what an... High-yield, some of the more exotic stuff, like asset-back-secure. in it, at least not to my knowledge, or it's very watered down.

And the other part of it is, as I was saying before, long duration hasn't worked because we've been in such a violent rate cycle. And if you've just been buying duration blindly, you have not had a smooth ride at all. So the active manager can lower down their duration risk, put it in some securitized stuff with low, you know, low duration, good interest, and there you go. Yeah. So you, it's fascinating to see all these different kinds of demands kind of showing up in the active ETF wrapper. So we have people who are buying these ultra-short funds.

They're obviously they want some kind of safety and income. There are people buying other kinds of income generating products like JEPB where you're selling calls on the S&P 500 and generating income. Then you have people buying these buffered products for downside protection. And then you have people who are just trying to get a little bit of leg up on the market and buy these index plus products where you're getting a factor overlay, either value, you're trying to have a value tilt or a small cap tilt. Especially when you've had growth be such a dominant factor for the last 10 years or so, and we've seen the results of that in the growth of those five to 10 names within the index,

which are all growth tech, large cap type names. So I gather, Nate, much of this is happening because ETFs are just simply a more tax-efficient wrapper for active management than mutual funds. I mean, it's actually as simple as that, isn't it? I mean, the flows from active mutual funds to active ETFs has been noticeable for a number of years now. Yeah, to what you were saying before just on the performance track record of active managers, particularly on the equity side, we've all seen that data. There are very real challenges that active managers face in generating consistent after tax outperformance.

And a big reason for that is simply overcoming their own management fees. and the tax structure of mutual funds, ETFs can help solve both of those issues because they're typically lower cost than mutual funds. They're certainly more tax efficient than mutual funds. And so that lowers the bar that active managers have to clear to generate alpha. So I think that certainly helps on the performance side. And the other thing I'll mention just in terms of the overall demand for active ETFs,

I actually think this is a case where supply is helping to, drive demand because we now have the biggest names in asset management who they're offering their flagship strategies and their best portfolio managers and an ETF wrapper. If you think back a few years ago, that wasn't necessarily the case. There were some real hesitancy from traditional active managers to embrace the ETF wrapper. But because of those benefits that I just described, I think that mindset is shifted. And so now investors have the ability to access strategies they simply didn't have in an ETF before. Yeah, I think that's, I mean, that's the bottom line, right?

It's just a more efficient wrapper. It's a way better wrapper, and also it was a get-with-the-program type message that Nate was just talking about. Money goes where it's treated best, and the results are clear in terms of EFTS versus mutual funds. Yeah. I want to ask you about dual-share class listings for ETFs and for mutual funds. Those who don't know, dual share class listings are being considered right now by the SEC. And it means you can access the same portfolio of stocks through two different formats, a mutual fund and an ETF.

It's the same portfolio, though. It's the same managers. It's the same holding, same everything. The advantage is that it reduces taxable events in the portfolio. It's a shared portfolio, essentially. Nate, could this help make it easier for issuers to long? active ETS, does this matter at all? I think without question.

I think that share class structure. Explain why too. This is a little nerdy for people that sort of wrap their heads around. Well, yeah. So you mentioned some of the benefits, particularly on the tax side, but also operationally, it lowers the back-in cost for an issuer to bring a product to market. And if you think about how that has historically been done, it's been done through what we call clone strategies. Some issuers have executed a mutual fund to ETF. find the ETF conversion, but that doesn't work in every case. And with this ETF share class

structure, they can simply tack on the ETF share class to existing mutual funds, and they're immediately in business. And if you think about this at a high level, a lot of traditional asset managers, they have the bulk of their assets in retirement plans, and 401ks, 403Bs, those sorts of things. That's a very lucrative business for them that they don't want to lose, but where is all the Well, we know all the growth is on the ETF side. And so what this ETF share structure would allow is for asset managers to have the best of both worlds, right? They can maintain that lucrative 401K business that they can pursue the much higher growth ETF market. So is this a, I mean, the SEC is considering this now.

This was by the way, those who don't know, the Vanguard had a patent on this that expired a couple of years ago. So this is why this is very exciting because they really did well with that. Oh yeah, they've made the ETF industry no sense and built up their brand as it is today. My only question, I don't have the answer is, okay, whenever they say, or we're going to go through with the share class, what is the order they allow everyone to do this? And is it everyone at once or is there a staggered start? And then, not that this is kind of out of my wheelhouse, but what is the operational effect? What does the plumbing look like if you all of a sudden have thousands of share classes of mutual funds coming out in a few days or weeks? Or what does that, does it impact the market at all?

I'm not sure. I'm just very curious what the plumbing looks like for this, or is it going to be a nothing burger like T plus 2 to T plus 1 once? Will this slow the conversion of mutual funds to ETFs that we can see? If you have a dual share class? Probably, because you'll have the share class of it. Nate, what do you think? Will this slow the conversion of mutual funds to ETS we've been seeing?

If we got a dual share class? I think 100%. Yeah, I don't see the need really for a mutual fund to ETF conversion. if you can simply tackle on the ETF share class. There may be some very unique example where examples where a mutual fund doesn't have much in the way of assets and retirement plans. And so perhaps it makes sense just to do a full ETF conversion. But I think a lot of the legacy asset managers,

they'll simply tackle that ETF share class. Now, you and I were just at the Exchange ETF conference. I was sitting in on a panel there of lawyers who said that this is imminent, that they think this could happen in the next three to six months. Yeah, there was how many firms, 50 or so lined up for this? So there's no question. 50 have applied for it. Yeah, 50 have applied.

I don't, barring some sort of unforeseen circumstance, I don't know why it wouldn't happen. Yeah. Especially 50 times how many assets from those 50. You're talking trillions of millions and dollars. Are you hearing the same thing, Nate? I mean, at the exchange ETF conference, there were some lawyers there that said this is going to happen. They felt very strong. Clearly, hot topic.

Yeah, no doubt, clearly a hot topic at exchange. My impression is that the general sense within the industry is that this will be approved probably before the end of the year. But I think Todd makes a good point in that let's say it's approved in the next several months. The question is which issuers are actually ready for showtime here? Because there's a lot on the infrastructure side that has to be established in order to make this go. And so that'll be another interesting side story. It's one thing to have this approved, but can you actually operationally execute this? Yeah, it's a fascinating question, actually.

It could really change things dramatically. I'm interested in it. I don't know the implications, and I'm not jealous of those who have to figure it out, to be honest with you. And especially in today's world where it's 24-7 headlines, the market ball of 20s on the rise. Yeah, it sounds great to me. I can't think of anything. Nate, is there any reason why we not be happy about this development? Is there something we should be concerned about?

It sounds right to me, but maybe I'm missing something. I think overall it's a win for investors. The SEC has expressed some concerns over what they call cross-subsidization, where essentially trading costs and other costs, say in the mutual fund might impact ETF shareholders or if you had massive outflows from a mutual fund and perhaps that cost some sort of taxable event, that that could negatively impact ETF shareholders. So I think there are some cases on the edge that, that it could be a negative for investors,

but I think overall it would clearly be a way. Yeah, that seems the way to me. Yeah, there's a couple examples of that, which I can't remember if the time ahead, that Nate was talking about out with how a full of mutual fund impacting the ETF. Now it's time to round out the conversation with some analysis and perspective

to help you better understand ETFs. This is the Markets 102 portion of the podcast. Codzone Straticus, head of ETFs continues with us now. I just wanted to, it's the last day of the quarter and sort of review what happened in the quarter. January and February, we're much different than what happened in March, but in terms of flows, where the money is going, what stuck out? Yeah, so well, equities at the high level are still doing about $3 billion per day.

That's on pace with last year's influx 2, yet the market is a completely different position down for the first quarter instead of up 24, 25 percent like last year. When you dig into the categories, away from equities, you've had a pretty staggering amount into cash like ETFs, right? Super short duration. You're getting income, you're getting low ball, safety from stocks, and a lot of money also as well into gold in Europe. I wonder if that's part portfolio diversification and performance chasing as well. Well, that's interesting because I looked at gold flows at the end of February in January of February there wasn't much there even with gold. I was kind of wondering and most of us felt that the reason gold was going up was

central bank buying and that wouldn't they're not buying ETFs obviously. They're buying bullion. No. I think you finally got some models to add gold, realizing, okay, we need it in this environment. And maybe some retail, too, realizing, oh, it's a 5,000-year high. Crypto's kind of stalling out. Stocks aren't working as much. So let's pile into gold. Okay, so you saw inflows in the first quarter into cash, meaning like ultra-short bonds. So inflows into gold, finally. And what about Europe? Europe. So I think Europe is part performance chasing because it's been so strong. and also maybe some allocators out there realizing,

okay, we've been overweight tech and growth for way too long. Let's dial that back. Let's go overseas where there is some value and a little more attractive in terms of valuations compared to the S&P 500. And what about outflows? Outflow is interestingly energy. Energy's showing some signs of life

in terms of trying to improve. I think that's probably more defensive play. And then small caps. And this is not the environment for small caps. And it hasn't been. And now you're starting to see some folks, throwing the towel there, which is kind of interesting to me that when this market corrections all set and done, that's kind of actually when you want to start to buy small caps,

coming out of really recent buyers. That's a good question. What is the environment for small caps? Not when the economy is slowing, right? No, it's usually coming out of recession and deep corrections because it's a go out and buy all the junk that's out there, right? Super high beta risk on. And that can be fleeting. It's hard to time, but that's really when you want to buy small cap stocks. We're not there yet, but seeing outflows, some of the worsening economic data kind of has my interest peaked in terms of starting nibble there. Yeah. Does it smell like a bottom to you? Like today we had a big turnaround, middle of

the day at least. The turnaround is nice. Does it smell like a bottom? There's some signs of it. The money going to cash. All the survey data is very bearish. I don't know if maybe you need one more flush before it's all said and done. But we're getting there, right? We're getting there. Cool. I heard there was 200 some new launches. of ETF launches in the first quarter? That's a huge number. Why is this happening? It's booming.

ETS are booming. 230 some odd new ETSs. That's a record for the first quarter of the year. And it's coming from everywhere. Active equity, active fixed income, derivative usage, single stock levered ETFs for better and for worse, all sorts of option-related ETFs where you're going to return stacking, right?

That's kind of the phrase now where you can stack single-stock ETFs together, or single-stock equities together. It's just a rush, right? It's a grab because ETFs are being so powerful. It's where all the money's going, so everyone wants a piece of the pie. So the plain vanilla stuff is basically over. This is more innovative stuff. We've moved from the passive area to the complexity era.

There's no question about that. Maybe some laggards out there may launch their own core products because they have some advisors who want them. But we have moved on. We've moved into risk management. We've moved to structured outcomes. any sort of income plays, right? That's where we are now.

Yeah, you charge more for them. Yeah. Well, there is a demand for this. We said this many times. It's not like they're foisting garbage on us. No. People want income. So they like ultra-short stuff.

They want products like, you know, Jepi that sells the S&P 500, that sells options and you've got to collect income on it. Investors are looking for ways to protect or shield their core. because they've been sitting on the core, they're not selling it unless they're transferring wealth to a younger generation. So they want the income, the buffers, the options to manage any sort of downside. It makes some sense. Todd, thanks very much.

Appreciate you being here. Thank you. Todd Sowness was fatigues. That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week or go to our website. All the shows are there, etfedge.c.c.combec. How does InvestcoQQQQR rethink possibility?

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